New rules for a rewarding retirement

Commentary: Know where you’re going; understand where you are

BOSTON (MarketWatch) — Most financial rules of thumb have been around for decades, offering guidance like “Subtract your age from 100 to determine the percentage of assets you should hold in stocks,” or “To retire comfortably, your investments must generate 75% of your final salary.”

The advice is more imprecise than incorrect, but it frequently is used as gospel. As the late Lynn Hopewell, former editor of the Journal of Financial Planning, once told me: “Rules of thumb are for people who want to decide things without thinking about them.”

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This week, however, Fidelity Investments unveiled what amounts to a new financial rule of thumb, in the form of retirement-savings guidelines based on its research, effectively laying out a road map that allows workers to check their progress at key points along the way.

The take-away on the research is likely to be considered the next financial axiom: “Employees need eight times their ending salary to meet basic retirement income needs.” That is the target that people will now be setting and the number they will be aiming for, rather than making decisions about a personalized, appropriate savings level.

Before Fidelity’s research moves from suggestion to perceived financial guideline and, potentially to “rule of dumb,” it’s important to understand what the company was attempting and how it intends its numbers to be used.

For starters, Fidelity didn’t just give the final target number, but rather set up checkpoints — markers on the road of life where someone might want to measure their progress toward the ultimate goal. While acknowledging that every individual situation differs based on someone’s desired retirement lifestyle, Fidelity’s target is replacing 85% of pre-retirement income.

Right off the bat, that means they have changed the older rule of thumb that talked about needing your investments to generate three-quarters of your pre-retirement income.

Having sufficient funds to generate 85% of your final salary by age 67 will require hitting the benchmark number of eight times final salary, Fidelity said.

Getting there, however, will require that a worker save about one times his or her salary at age 35, three times his or her pay at 45 and five times the salary at age 55.

The markers are based on a hypothetical worker saving in a 401(k) or similar workplace-retirement plan starting at age 25; working and saving continuously until retirement at 67; and living until he or she reaches age 92. (It’s important to note that Fidelity said the final goal would include all savings, and not just the dollars set aside in the workplace program.)

Further, the basis is for that worker making continuous contributions to a retirement plan, starting at 6% of salary when he or she starts saving at age 25, and rising 1% per year until reaching 12%. Additionally, the worker is getting an additional, ongoing 3% contribution from the employer during their working life.

The money the worker saves grows for life by an annual average rate of 5.5%; the employee’s income grows by 1.5% over general inflation with no breaks in employment or savings; and the amount of necessary savings would be even higher if it were not for Social Security.

Plan ahead

Now you see why people who use rules of thumb don’t necessarily understand what really went into setting the standard. (It’s like people saying that “Stocks will return an average of 10% per year,” without accounting for the fact that the historical research underlying this assumption never factored transaction costs or mutual-fund expenses into the picture.)

Go through a period of unemployment or take a few years off to raise kids, and the growth picture changes. Start saving smaller, and you’ll spend most of your life playing catch-up. Fail to get a 5.5% average return, or see no pay increases — or inflation swallowing virtually all of any raise — and you’re headed off the road.

That’s before anyone factors in how changes to Social Security might impact generations of retirement savers.

Do the checkup to see where you stand at any point in time, and you might find yourself deep in the woods. Or you might find yourself on pace with say, three times your salary saved up at age 45, but unaware of what goes in to making the next interim goal 10 years closer to retirement.

Where this becomes a rule of thumb is in the idea that it doesn’t matter so much where you start, but how you finish, with eight times the salary as a nest egg.

“It’s not like you can start at age 25 or 30 and set it and forget it,” said Jeanne Thompson, vice president of market insights at Fidelity. “As you age and move along in your career, you need to constantly re-evaluate your savings level and your asset allocation … to make sure that for the rule of thumb, you are where you are supposed to be.”

Thompson acknowledged that some people might check themselves against the guideposts and be terrified. “For the folks who might look at this and say ‘I’m not on track,’ the best recommendation is to evaluate where you can make some adjustments. Maybe they can start to save a little bit more … and they may want to think about the possibility of having to work longer, so that when they do retire they have enough, or adjusting [their] lifestyle in retirement.

“The vision you have for your retirement, based on what you save, may or may not be able to happen if you are a little bit off-track,” she added.

Ultimately, the take-away from Fidelity’s research should not be the retirement level — which is what most people will focus on — but the points along the way. If you don’t have a year’s salary saved by age 35, it’s time to start playing catch-up rather than wait to see where you stand at 55 heading into the home stretch.

The finish line might be the same, but the journey to get there can be easier if you have a good idea that you’re on the right track.

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